Wise Wealth Management

Dennis Covington | Principal

Insights on the keys to enjoying a "healthy wealth".

Can We Use a Trading-Range Strategy to Time the Market?

June 2009

As we develop wealth management plans for our clients we find that discovering their goals and creating a plan to maximize the probability that they achieve these goals is sometimes the easiest part. The more difficult part, particularly in volatile markets like 2008, is putting the plan into action, particularly when it involves putting cash into the market. Why? One word – EMOTION.

We’ve had success with several clients who struggle with the decision by introducing a process that creates discipline and minimizes emotion. The process typically includes buy triggers that occur as a broad market index drops OR upon time intervals should the broad market index stay flat or rise. The important part is not the index or the selected trigger points but that there is a disciplined process that removes emotion from the decision.

Interestingly, in the midst of the recent market volatility, one of my clients asked about the other side of this coin, so to speak. He wanted to know if we wouldn’t have been better off using “sell triggers” that would have kicked in at a certain point so that we could have gotten out of the market and protected our assets from the twin bear markets we have experienced in the past ten years; for example, selling when the Dow climbs into a range between 13,000 and 14,000, and then buying back in when the Dow is in a range between 7,000 and 8,000. In such a scenario, the investor would try to generate all of the returns needed to fund retirement from the interest earned sitting in cash and from the appreciation between 8,000 and 13,000 on the Dow.

To see the problem with such an approach, let’s take a look back at June 1982:

An investor at that time would have looked back over the past two decades and seen a trading range in the Dow that was clearly evident, as seen in the graph below:

The Dow had flirted with the 1,000 point threshold on five occasions over that 20-year period, only to fall back to the 600 point level on two occasions and under 800 several other times. This represented drops of 40% and 20% respectively. It would have been very compelling in 1982 to implement a strategy that took advantage of this trading range, jumping out of the market around Dow 1,000 and then buying back in around Dow 700. 

The only problem is that after November 23, 1982 the Dow never went under 1,000 again. 

Now the investor would have had to decide when to get back in the market. Even harder to stomach would be the idea of making your old “top” your new “bottom” and establish a new range between, say 1,000 and 2,000. 

Such a strategy would have been nerve-wracking and ineffective in light of the Dow’s run over the next 20 years (and keep in mind this is a price-return graph that doesn’t factor in the reinvestment of dividends, which is historically 40% of total return): 

When the investment objective is retirement and you have a 20+ year time horizon, equity investing makes all the historical sense in the world. The trade-off is that you've got to BE IN THE MARKET to earn those equity rates of return. Anything else requires adhering more to guesswork than to disciplined strategy, and that is no basis for investment management.

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